1 Chapter 10 Stock Markets © 2001 South-Western College Publishing Company

2 Chapter Objectives nDescribe the stock exchanges where stocks are traded nExplain the institutional use of stock markets nDescribe the globalization of stock markets

3 Background on Common Stock 4Common stock = certificate representing partial ownership in a corporation 4Issued by corporations that need long-term funds Issued in the primary market Stock is then traded in the secondary market, creating liquidity for investors

4 Background on Common Stock nOwnership and voting rights 4Owners of common stock vote on: Election of board of directors Authorization to issue new shares Amendments to corporate charter Other major events 4Many investor assign their vote to management via a proxy 4Households own about half of all common stock, the rest is owned by institutional investors

5 Background on Preferred Stock nRepresents equity interest, but usually no voting rights nStated fixed annual dividend nDividend may be omitted 4Cumulative provision

6 Public Placement of Stock nInitial public offerings (IPOs) First-time offering of shares to the public Firm must provide information to public –Prospectus Firm is assisted by a securities firm 4Performance of IPOs Price generally rises on first day –Internet firms Longer-term performance of IPOs is poor

7 Stock Exchanges nOrganized exchanges 4Execute secondary market transactions 4Examples: NYSE, AMEX, Midwest, Pacific 4NYSE is largest, controlling 80 percent of value of all organized exchanges Must own a seat on exchange in order to trade Trading resembles an auction

8 Stock Exchanges nOver-the-counter market No trading floor Telecommunications network 4Nasdaq National Association of Securities Dealers Automatic Quotations Thousands of small firms, plus high-tech giants 4Pink sheets Tiny firms that do not meet requirements for NASDAQ

9 Stock Indexes nDow Jones Industrial Average 4Price-weighted average 430 large U.S. firms nStandard and Poor’s (S&P) 500 4Value-weighted 4500 large U.S. firms nNew York Stock Exchange Indexes nOther Stock Indexes 4Amex, NASDAQ

10 Stock Indexes nInvesting in stock indexes Indexing Has become very popular –Lower transactions costs –Studies find that actively-managed funds do not outperform stock indexes 4Examples of publicly traded stock indexes SPDRs Diamonds

11 Institutional Participation in Stock Markets nProgram trading by institutions Simultaneously buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million Most commonly used by securities firms Program refers to the use of computers 4Impact on stock volatility Often blamed for rise or fall in stock market Studies show that program trading does not increase volatility

12 Investor Monitoring of Firms in the Stock Market nShareholder activism An investor who is dissatisfied with the way managers are running a firm has 3 choices: –Do nothing –Sell the stock –Engage in shareholder activism

13 Corporate Monitoring of Firms in the Stock Market nPotential benefits of an acquisition nMarket for corporate control 4If price declines due to poor management: subject to possible takeover nBarriers to corporate control 4Antitakeover amendments 4Poison pills 4Golden parachutes

14 Impact of the 1987 Stock Market Crash on Financial Markets 4October 19, 1987 U.S. stock market declined almost 23% nImpact on diversified stock portfolios 4Because even diversified portfolios contain systematic, or market, risk, these portfolios fall with overall market declines

15 Globalization of Stock Markets nHow barriers to international stock trading have decreased 4Reduction in information costs 4Reduction in exchange rate risk nForeign stock offerings in the United States nInternational placement process nGlobal stock exchange characteristics nEmerging stock markets

16 Globalization of Stock Markets nMethods used to invest in foreign shares 4Direct purchases 4American Depository Receipts (ADRs) 4International mutual funds 4World equity benchmark shares

17 Globalization of Stock Markets nGlobal diversification and integration among stock markets 4Integration of markets during the 1987 crash All major stock markets declined, indicating the underlying cause systematically affected all markets 4Integration of markets during mini-crashes Ex: August 27, 1998 “Bloody Thursday” –Russian financial crisis